Bad Dreams Under Alternative Anchors: Are the Consequences Different?

IMF Working Papers, January 1, 2000

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Bad Dreams Under Alternative Anchors: Are the Consequences Different?

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Bibliographic details

• Authors: Leonardo Auernheimer, Susan M George
• Published: January 1, 2000
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451843835.001

Summary

• Using a simple model, the paper shows how a strict monetary rule exhibits characteristics similar to those of an exchange rate anchor, in terms of a lack of robustness in the presence of adverse expectations (“bad dreams”).
• An anticipated devaluation under an exchange rate rule leads to contractionary effects.
• An anticipated increase in the money stock under a monetary rule, though initially expansionary, becomes contractionary when these expectations are not validated.
• The evidence suggests that much of the criticism of an exchange rate anchor implicitly considers not another rule but rather, discretion as the alternative.

Key findings

• Strict monetary rules can mimic the vulnerabilities of exchange rate anchors when agents form adverse expectations.
• Anticipated policy actions can have reversed effects if expectations are disappointed:
  • Anticipated devaluation (exchange rate rule) → contractionary effects.
  • Anticipated increase in money stock (monetary rule) → initially expansionary but becomes contractionary if not realized.
• The paper emphasizes the role of expectations in determining the real effects of alternative nominal anchors.

Policy implications

• Policymakers should account for expectation-driven channels when choosing between exchange rate anchors and strict monetary rules.
• Critiques of exchange rate anchors should clarify whether the intended alternative is another rule (e.g., a monetary rule) or discretionary policy, since outcomes differ when discretion is the implicit comparator.
• Robustness to adverse expectations is a key criterion in assessing nominal anchors.

Subjects and keywords

• Subjects: Exchange rate adjustments, Exchange rates, Financial services, Foreign exchange, Monetary base, Money, Real exchange rates, Real interest rates
• Keywords: money stock, real interest rate, WP

Content in this bundle

• Bad Dreams Under Alternative Anchors: Are the Consequences Different? - WP/00/20
  • Bad Dreams Under Alternative Anchors: Are the Consequences Different? - WP/00/20 (Markdown version)
  • Bad Dreams Under Alternative Anchors: Are the Consequences Different? - WP/00/20 (PDF)